Directive 96/10/EC of 21 March 21 1996 amending Directive 89/647/EEC as regards recognition of contractual netting by the competent authorities

1. Aim of Directive 96/10/EC

The aim of Directive 96/10/EC of 21 March 1996 (amending Directive 89/647/EEC as regards recognition of contractual netting by the competent authorities) is to amend Annex II of the Solvency Ratio Directive (89/647/EEC) for credit institutions. This Annex II deals with the treatment of off-balance sheet items concerning interest and foreign exchange rates in the context of the calculation of credit institutions' capital requirements.

The original text of Annex II of the Solvency Ratio Directive only recognized bilateral contractual netting by novation as a risk reducing factor. The new directive enables national supervisory authorities to recognize other forms of contractual netting, e.g. close-out netting, as a reducing factor for the calculation of present credit risk (the changes also apply to Directive 93/6/EEC of 15 March 1993 on the capital adequacy of investment firms and credit institutions and Directive 92/121/EEC of 21 December 1992 on the monitoring and control of large exposures of credit institutions).

2. Conditions for recognition

The national supervisory authorities, such as the Banking and Finance Commission in Belgium ("BFC"), may recognize contractual netting as risk reducing only under the following three conditions:

(i) The netting arrangement must be included in a standardized agreement.

(ii) The credit institution must have made available to the supervisory authority "written and reasoned legal opinions" addressing the relevant issues. Neither the Directive nor its preparatory documentation provide any further details on this issue.

(iii) The credit institution must have in place a procedure to keep the legal validity of the contractual netting arrangement under constant review.

3. Implementation of the Directive into Belgian Law

The BFC regulations on own funds of credit institutions and stock broking firms of 5 December 1995 already include the possibility for the BFC to recognize under certain conditions bilateral contractual netting agreements for risk reducing purposes.

The BFC regulations even extend the rules for bilateral contractual netting agreements to multilateral netting agreements for derivative currency instruments (based upon the interpretation by Basle Committee of its Capital Accord - April 1996). The European Commission prepares a similar interpretation of its directives.

The conditions are similar in both BFC regulations and constitute a close copy of the conditions for recognition under the Directive.

The words "written and reasoned legal opinions" in the English version of the Directive have been translated by well founded (well reasoned) legal advice ("schriftelijke en met redenen omklede juridische adviezen"/"avis juridiques ecrits et dument motives") in the Dutch and French version of the Directive. The latter wording has been taken over into the BFC regulations.

In view of the complexity of the matter and the involvement of various foreign law regimes, it is likely that most banks will rely on external advice. For certain credit institutions and stockbroking firms which do not have sufficient in-house know-how this may be the only acceptable solution. No proposals have yet been submitted to the BFC, but the banking sector (in particular the Belgian Association of Banks) is looking at options to join forces. Thus, it is not excluded that collective advises in one or another form may be submitted to the BFC.

The content of this article is intended to provide general information on the subject matter. It is not a substitute for specialist advice.

De Bandt, van Hecke & Lagae - Brussels (32-2) 501 94 11